WALKING WITH GIANTS
China's TCL aims to become the next Sony. CFO Vincent Yan is trying to make sure the bold dream does not turn into a nightmare.
By Cesar Bacani

The headquarters of mainland Chinese television maker TCL International is distinctly rundown. TCL Tower is a box-like industrial building on a side street in Tsuen Wan district, way out in Hong Kong's New Territories. A narrow hallway leads to a cramped elevator lobby. On the 13th floor, a maze of partitioned cubicles seems to take up all the available space. In the conference room, no one seems to notice or care that the blinds that curtain the picture windows are askew. Some of the slats have fallen off.

Managing director and CFO Vincent Yan is oblivious of the broken blinds. He is focused on the future. "We want to be the next Sony," he says in his virtually accent-free English. "We want to be the next Samsung." Articulate and quick-witted, Yan is a reminder that while TCL's offices may look Third World, its people bear all the stamp of being world class. The CFO was primed to defend his PhD dissertation in computer science at Peking University when the Tiananmen protests erupted in 1989. A pro-democracy sympathizer, Yan ended up doing an MBA at America's Stanford Business School instead.

At 41, Yan is poised for a bigger role on the global stage. He is a key player in CEO Li Dong Sheng's negotiations with Charles Dehelly, who heads France's Thomson Multimedia, to set up TCL-Thomson Electronics. If the deal is finalized, TCL would become the world's largest television maker, turning out 18 million sets for 19 percent of the Chinese market, 12 percent of America's and 8 percent of Europe's. Due to be operational by July, the TCL-majority-owned joint venture will own and manage the TV and DVD assets of the two companies. These even include household names such as the US consumer electronics brand RCA. Li will be chairman, Dehelly vice-chairman, and Yan the likely CFO.

It's a great time to be young, ambitious and a CFO in China. The country's rapidly growing companies realize they need savvy financial talent not only to deal with evolving accounting standards and new reporting requirements, but also raise capital in the most creative ways and keep costs low and efficiency high by tracking key performance metrics. For corporations with global goals like TCL, the CFO has the added responsibility of interfacing with often skeptical international investors, regulators, and business partners. It's a surefire career-maker for anyone who can rise to the occasion - and a heart breaker for someone who cannot deliver.

But even for the go-getting top brass of TCL, becoming the next Samsung or Sony is a mammoth aspiration. The Korean and Japanese giants took years to build their businesses and establish their brands globally, and both have successfully diversified into some of the highest-margin businesses in electronics. TCL makes mainly televisions (82 percent of revenues from direct operations) and personal computers (12 percent). It also has a 40.8 percent stake in mobile phone maker Huizhou TCL Mobile Communication. To say that it has a long way to go is an understatement, but as the Thomson venture shows, Li and Yan are taking bold steps..

All the Right Moves

Analysts are positive on the TCL-Thomson deal, but there are the inevitable worries. Will a bulked up TCL continue to be the mean and profitable machine that it was last year, when it earned HK$642 million (US$82.5 million, up 12 percent from 2002) on sales of HK$15 billion? "The key risks include [the strength of] Thomson's sales network, execution integration and product-pricing issues," Min Lu, industry analyst at Merrill Lynch in Hong Kong, wrote in a report. But if the joint venture gets it right, she expects TV sales to reach HK$41.6 billion, nearly triple TCL International's total.

So far, Yan has been on a hot streak. Li recruited him in 1999 to become his assistant. The two men got to know each other when Yan was disposing of computer maker Tulip Asia, where he was country manager for China, after the parent in the Netherlands went bankrupt. Yan spoke to TCL, but sold Tulip to another Chinese conglomerate. The new owners thought he was too expensive. TCL was willing to pay a premium for talent and Yan came onboard.

TCL at that time was still majority-owned by the local government of Huizhou, a city in the southern province of Guangdong near Hong Kong. Li, who spent two years toiling in the boondocks during Mao Zedong's Cultural Revolution, got together with several engineer friends in 1982 to set up a cassette-tape company using assets of the Huizhou government's Machinery Department. The firm later branched out to the design and manufacture of corded and cordless telephones (TCL stood for Telephone Communication Limited). The group entered the television market in 1992, computers in 1998 and mobile phones in 1999.

Li so impressed Huizhou authorities that they agreed to give him a free hand in running the group. He pulled off another first this year: the government agreed to dilute its 80 percent ownership in TCL Corporation to just 25 percent after the enterprise listed on the Shenzhen Stock Exchange in January. In the past, Beijing always kept at least a 50 percent stake in a large state-owned corporation. The speculation is that TCL is being used to test the theory that freeing a company from state control would help it crack global markets. The privatization of other state-owned enterprises could well ride on TCL really emerging as the next Sony.

The group has a lot on its hands and Li depends on Yan, just four years his junior, to help carry the load. At TCL Corporation, Yan is a board director and continues to hold the title of assistant to the president. He has also been named interim head of strategic planning. At TCL International, which is listed in Hong Kong, he has just been promoted to managing director, a post that is concurrent at the moment with the position of CFO. Next to Li, Yan probably has the best grasp of the TCL group's strategy and finances..

Talking with Thomson

From his listening post in financial center Hong Kong, Yan learned Thomson was looking for a Chinese partner. Thomson is said to be anxious to dial down its involvement in the low-margin TV business so it can focus on becoming a provider of end-to-end solutions for entertainment industries. Li and Dehelly started talking in July last year. "We learned with excitement that Thomson had a whole merger proposal for a Chinese manufacturer," recalls Yan. "When we met, Charles Dehelly explained the model to us. It was a full merger, not a simple joint venture."

TCL had been thinking along the same lines. "About two years ago, we started rethinking the business model of being an original equipment manufacturer for multinational companies," says Yan. "But it's not just realistic to build a new brand in a mature market like North America. You just don't have the kind of profit margin for that. So we proposed the idea [of a merger] to our then partner - I can't say who this is - but it was very slow. They did not give us any answer." Thomson was more receptive. Just four months after initial contact, the two sides signed a binding memorandum of agreement in November. A combination agreement was finalized in January when Chinese President Hu Jintao made a state visit to France.

TCL will inject into the joint venture TV and DVD manufacturing plants in China, Germany, and Vietnam, R&D centers and sales networks. Thomson will contribute TV manufacturing plants in Mexico, Poland, and Thailand, DVD sales business and TV and DVD R&D centers, including those for digital technology, and a credit line. TCL values its assets at up to 220 million euros (US$174 million), including working capital of between 120 million euros to 140 million euros. Thomson places the value of its contribution at 170 million euros, not including a yet-to-be-determined credit line.

Some analysts say the Chinese are getting the shaft because they are putting in working capital while the French contribution is a loan that must be repaid. But to TCL, 140 million euros is cash well spent compared with the US$500 million or so it would have needed every year to introduce and nurture its brand in the US - that's how much Samsung is said to be spending. "And we're getting a 67 percent stake in the JV while Thomson gets 33 percent," Yan points out. "That's because our business is profitable while some of Thomson's businesses are losing money." Going by pure valuation, the ratio should have been 57 percent for TCL and 43 percent for Thomson.

Yan and his staff did a discounted cash flow analysis, looked at the synergies, and examined the execution difficulties. "As a whole, Thomson's consumer segment is not making money, but TV sales in Europe are fine," says Yan. RCA, the US brand Thomson bought from General Electric in 1987, is doing less well, and Thomson's consumer division lost 124 million euros in 2003 largely because of it. Anti-trust issues in the US have prevented TCL from looking into RCA operations as closely as Yan would have liked. "But we have a rough idea [as to why it is losing money].

It's the business model, how you sell, how you price, the entire product mix." Another potential problem was assigning a cash value to the three brands. RCA is a long established trademark in America, with the image of the little dog Nipper sitting in front of an antique phonograph almost an icon there. The solution: the partners retained ownership of their brands, but agreed to license the trademarks to TCL-Thomson for 20 years. The joint venture will pay the same rate - "far lower than the market rate," says Yan - for all three brands, in effect valuing them equally. Thomson will be the main brand in Europe, RCA in the US and TCL in Asia.

Why a joint venture and not a direct acquisition of Thomson's TV and DVD assets, as TCL did in 2002 when it bought the assets of German TV maker Schneider? Yan says Thomson proposed a JV rather than a straight-out sale because it wanted to remain part of the global TV market. "Thomson believes it has a bright future [in partnership with TCL]," says Yan. "It will nominate the president and the vice president for Europe and North America, among other positions, so it really intends to ensure the joint venture's success." Thomson will have the option to swap its shares in TCL-Thomson for shares in TCL International, which will then wholly own the joint venture.

Execution Blues

The talks are going well, but implementation will be tougher. The Chinese side is willing to let Thomson take the lead outside of Asia. Yan does not foresee factory closings, especially since TCL-Thomson would need non-Chinese plants to manufacture television sets for the US market. The US has issued a preliminary anti-dumping ruling against TCL for supposedly selling TVs below cost under its OEM contracts. (Yan declines to name the international brands that outsource to TCL, but press reports say Philips and Panasonic are among them.) TCL-Thomson can get around the ruling by utilizing Thomson's plant in Mexico or TCL's factory in Vietnam.

The immediate problem would be RCA. Based on current information available to the company, Yan believes RCA's bottom line will benefit from adding more low-cost TVs to its product range. "RCA is the leader in plasma TVs and other high-end models in the US," says Yan. "But it does not have enough low-end products to support its pricing strategy. So when [competitor] Apex made a big push into the low-price market in 2003, RCA could not compete."

Yan sees RCA's plasma - those hang-on-the-wall picture-thin screens - coming to China as a premium brand, with TCL's own models priced slightly lower. "Currently we don't have advanced [plasma TVs] available in the market," he says. The Thomson brand can also be introduced in the projection-TV segment. Combined with TCL's medium-priced flat-screen but bulky cathode-ray tube (CRT) TVs and cheap 20-inch and smaller CRTs, the plethora of brands would allow flexibility in pricing. "It's not always the case that profit margins from high-end TVs are fatter than those in the lower end," says Yan. In China, margins from liquid-crystal display models are actually thinner because of fierce competition.

Other strategies include leveraging TCL-Thomson's greater clout in sourcing materials to further cut costs and maximizing capacity by juggling production based on consumer preferences and market-access considerations. "This is synergy," Yan exults. "It will be a question of balancing global manufacturing trends." The benefits should extend to multi-brand use of sales and service networks worldwide and cross-pollination of ideas among TCL-Thomson's various research and development centers in China, France, Germany, and the US, which would hopefully enable the company to compete in cutting-edge TV technology with the likes of Sony and Samsung.

Balancing Act

One issue that would need to be finessed would be the question of original equipment manufacturing. Started only recently, the OEM business has been surging - TCL exports were up 195 percent to 3.8 million units in 2003 - and sales to the US now account for about 6 percent of total revenues. But how comfortable would other TV makers be in subcontracting to a company that competes directly with them around the world? "It depends," says Yan. "As long as you differentiate the products enough, you should have the comfort level. It would be a matter of trust [that] the joint venture would conduct the business ethically." He concedes, however, that discussions are ongoing about existing OEM contracts in relation to the creation of TCL-Thomson.

The depth and quality of TCL's management bench will also be tested, although TCL is more Western-oriented and transparent than most Chinese firms, and its investor relations team is winning plaudits from both fund managers and analysts. Industry observers wonder how TCL will manage Thomson's marketing networks in Europe and the US. Can mainland executives who are used to compliant Chinese workers handle independent-minded and often unionized French and American employees? The answer is that they will not. Thomson will continue to oversee Europe and North America.

The key learning for TCL from the Schneider acquisition, says Yan, is the importance of recruiting the best German managers and then getting out of their way. Local managers know their home market best.

"We think Thomson has managed its businesses pretty well under the circumstances," says Yan. "Its retail network covers around 80 percent of European distribution. In North America, it has 10,000 retail outlets and 220 distributors, including Wal-Mart, Best Buy, Circuit City, Target, and Carrefour." He defends Thomson's R&D capabilities, which have been questioned by some analysts. "Thomson does not lag behind competitors in high-end products," Yan insists. "It has advanced technology in digital TV and rear projection TV, [a segment] in which it has 10 to 15 percent market share in the US and more than 25 percent in Europe."

Internally, the joint venture may force changes in TCL International and its parent. In its listing prospectus, TCL Corporation said it would gradually concentrate on mobile phones and home appliances. In a filing with the Hong Kong exchange, TCL International said it would focus on TVs, DVDs, and computers, and would thus consider restructuring its 40.8 percent stake in Huizhou TCL Mobile Communication. After soaring last year on the back of the Thomson deal, TCL International's stock price fell on the disclosure. Dividends from the handset maker accounted for half of its earnings in 2002, but only for a third in 2003 as tight competition forced Huizhou to cut profit margins. "We will make sure that the interests of minority investors are protected," Yan promises. The market will expect transparency, especially in the valuation of the assets to be sold to the parent firm.

Why jettison the profitable cell phone line, keeping instead the struggling computer division, which made only HK$31.2 million in operating profits last year, compared with HK$810.6 million for handsets? TCL says mobile phones are a non-core business like the losing white goods line it sold to its parent in 2002 for a profit of HK$8 million. Computers, on the other hand, are an important part of TCL's 3C - computers, communications, and consumer electronics - convergence strategy. Four months ago, the company established a laboratory in China in partnership with Intel. The two companies will jointly develop interconnection and inter-operation technologies to unify the three different products.

Catching Up

TCL is not the only Chinese company to harbor global ambitions. Beijing has made no secret of its desire to develop its own multinationals. China's number-three TV maker Konka made a splash in the US in the late 1990s with its ultra-cheap televisions. It pulled out after losing too much money. White-goods manufacturer Haier now boasts a 50 percent market share of America's small fridges and wine coolers segment, but has yet to make headway in large refrigerators, freezers, and air conditioners. Computer company Legend, telecom equipment group Huawei Technologies, and oil company CNOOC are beginning to try their wings abroad.

But TCL is clearly in a class of its own. No one has been as bold as Li in leveraging his company's manufacturing prowess and understanding of Chinese and Asian markets to walk with giants - and to swiftly try to become one himself. "He is the driving force here, as he is with everything else in the company," says Yan. He is determined to help Li achieve his vision. Yan knows how far he and his colleagues have to go - at US$3.5 billion, TCL-Thomson's combined sales are still a fraction of Sony's US$62.3 billion and Samsung's US$50.7 billion. The joint venture may make six million more TVs than either Sony or Samsung every year, but it is nowhere in DVDs, MP3 players, game consoles, music, and movies.

No wonder fixing window blinds, let alone a gleaming office tower, is not yet a priority in the TCL scheme of things.